The Unfairness of the Buffett Tax

April 23, 2012

According to a recent poll, nearly two-thirds of Americans agree that the idea of hiking tax rates on rich people would be fairer to the non-rich taxpayers. However, the mechanism for accomplishing this goal provided by the Buffett Rule will have untold unintended consequences, says Steve Conover of the American Enterprise Institute.

First and foremost, it must be understood that in order to accomplish its goal of raising the effective tax on the rich, the Buffett Rule will have to target capital gains.

The tax would phase in a minimum tax for those with incomes of $1 million or more.

This phased-in percentage would rise to a minimum of 30 percent for incomes of $2 million or more.

This would set an effective floor on the tax rate of the rich, such that the payoff from financial planning would be minimal.

Second, it must also be understood that by targeting capital gains with this tax hike, which is where most of the rich get their $1 million-plus incomes, the tax provision will likely miss its target. Rational taxpayers respond to tax hikes by altering behavior in order to minimize their tax burden.

The rich have the ability to put off the liquidation of assets for several years as they wait for a more-friendly tax environment.

While their assets continue to mature in this delayed liquidation scenario, they will owe no taxes.

This time-power of the rich will allow them to evade this tax hike legally until the rates are brought back down again.

This phenomenon can be seen repeatedly in America's tax history: tax revenues from capital gains have consistently gone up whenever the tax rate went down.

Finally, and perhaps most crucially, while the actual-rich will be able to evade the tax hike because of their above-mentioned time power, the non-rich elderly will not be able to.

When they retire, the elderly are forced to liquidate retirement investments at a particular time.

This means that they do not have the time power that the actual-rich possess.

Thus, the Buffett Rule will have the side effect of taking a larger portion of retirees' nest eggs if they are over $1 million in value.

Source: Steve Conover, "The Unfairness of the Buffett Tax," The American, April 17, 2012.